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Management of Financial Services PDF
Management of Financial Services PDF
Internal Marks : 30
UNIT - I
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External Marks : 70
Time : 3 hrs.
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UNIT - II
Information system for strategic advantage, strategic role for information system,
breaking business barriers, reengineering business process, improving business
qualities.
UNIT - III
Information system analysis and design, information SDLC, hardware and software
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UNIT - IV
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UNIT I
Q.
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Ans. Introduction : Financial services are an important component of the financial system.
There are four components of financial system.
Financial Institutions
Financial
Services
Financial System
Financial
Instruments
Financial Market
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Financial institutions and financial markets facilitate functioning of the financial system
through financial instruments. In order to fulfil the tasks assigned, they required a number of
services of financial nature. Financial services are, therefore regarded as the fourth element
of the financial system. An orderly functioning of the financial system depends to a great deal
on the range of financial services extended by the provider, and their efficiency and
effectiveness.
Financial services not only to help to raise the required funds but also ensure their efficient
deployment. They assist in deciding the financial mix and extend their services up to the
stage of servicing of lenders. In order to ensure an efficient management of funds, services
such as:
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Bill Discounting
Factoring of Debtors
Securitisation of debts
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Financial services differ in nature from other services. Some of the salient features of
financial services are discussed as follows:
Customer-Oriented : Financial services are customer-oriented. The providers of
such services study the needs on the customers in detail to suggest financial
strategies which give due regard to costs, liquidity and maturity considerations. The
providers of financial services remain in constant touch with the market. They design
both universal and firm-specific projects. This is due to the fact that the present day
firms happen to be different in terms of:
Size
Level of Output
(2)
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(3)
(1)
(4)
Perishability : Financial services like any other services cannot be stored. They have
to be supplied as required by customers. The providers of financial services have to
ensure a match between demand and supply.
(5)
Dynamism : Financial services have to be constantly redefined on the basis of socioeconomic changes such as disposable income, standard of living and educational
changes related to the various classes of customers. Financial services institutions
while evolving new services could be proactive in visualizing in advance what the
markets want, or reactive to the needs and wants of customers.
(6)
(2)
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(1)
(i)
Banks
(ii)
Financing Institutions
(iii)
Mutual Funds
(iv)
Merchant Bankers
(v)
Stock Brokers
(vi)
Consultants
(vii) Underwriters
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Q.
(i)
Discount Houses
(ii)
(iii)
(ii)
(iii)
(iv)
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(4)
(3)
Ans. Meaning of Financial Services : Financial services cater to the needs of financial
institutions, financial markets and financial instruments geared to serve individual and
institutional investors.
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Financial institutions and financial markets facilitate functioning of the financial system
through financial instruments. In order to fulfil the tasks assigned, they required a number of
services of financial nature. Financial services are, therefore regarded as the fourth element
of the financial system. An orderly functioning of the financial system depends to a great deal
on the range of financial services extended by the provider, and their efficiency and
effectiveness.
Government of India
Appellate Authority and Regulator in Certain Cases
Level II
Level III
Level IV
Regulators
RBI
SEBI
IRA
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Level I
Level V
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Level VI
Self - Regulation
By-laws, Rules and Regulation and Code of Conduct
Issued by the various Financial Service Industry
Associations.
Regulatory Framework : For the purpose of studying regulatory framework which govern
the financial services, we can divide the financial services in four different categories:
(A) Banking and Financing Services
(B) Insurance Services
(C) Investment Services
(D) Merchant Banking and other services
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(1)
(i)
(ii)
It prescribe the
Minimum capital,
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(A)
Distribution of dividends
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(iv)
(i)
It prescribes the types of companies which are eligible to raise funds from
public and its members.
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(ii)
(2)
(iii)
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(iii)
It also prescribes the extent to which the funds could be raised and the
terms and condition thereof.
(iv)
(v)
It also collects periodic reports and has the powers to collect information
on any aspect relating to the functioning of the NBFCs , conduct
inspection of the books of NBFCs and investigate on any aspects relating
to the activities of the NBFCs.
(vi)
(iii)
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(ii)
(ii)
(iii)
(iv)
To call for information from, undertake inspection and conduct enquires and
investigation including audit of the insurers, insurance intermediaries and other
organization connected with the insurance business.
(v)
(vi)
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(i)
(C)
(B)
(i)
The RBI has issued three major directions to regulate different forms of Non-Banking
Financial Companies and other financial institutions. They are:
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Securities and Exchange Board of India (SEBI) : The SEBI Act, 1992 entrusts the
responsibility of protecting the interest of investors in securities. They are:
(i)
Regulating the business of stock exchange and any other securities markets.
(ii)
(iii)
(iv)
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(D)
(v)
O
Insurance
Act, 1938
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Banking
Regulation
Act, 1949
Insurance
Services
Banking and
Financing
Services
Reserve Bank
of India
Notification,
Rules,
Directions, etc.
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Insurance
Regulatory
Authority
Investment and
Fee-based Services
Merchant Bankers
and Other Services
Securities Contracts
Act, 1956
Companies Act, 1956
Indian Trust Act, 1882
SEBI Regulations,
1992
SEBI
Regulations,
Guildelines etc.
SEBI Regulations,
1994
Ans. Meaning of Financial Services : The term financial services is broadly understood to
include banking, insurance, housing finance, stock broking and investment services.
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Classification of Financial Services:- Financial services include fund-based as well as feebased services.
(i)
Fund-based Services: In fund based services, the firm raises equity, debt and deposits
and invests in securities or lends to those who are in need of capital.
(ii) Fee-based Services: In fee-based services, the financial service firms enable other to
raise capital from the market.
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The financial sector is also known for its dynamic character and within a short period, it has
introduced several new products and services. Though the sector is growing rapidly all over
the world, the financial markets have seen a number of bank and insurance companies
failure and market crashes. The industry is operating in an environment where the risk is
very high.
Trading in Risk : There are two types of risk involved in financial services:
(1) External Risk
(2) Internal Risk.
External Risk : It could be due to changes in interest rate in the market that reduces
the value of existing financial claims. As these are events arising outside the company,
they can be grouped under external sources. The following are few external sources of
risk:
Institutions Providing Direct Finance : There are different types of institutions
available in the financial market providing finance for various requirements.
There are many examples:
(i)
(1)
Commercial Banks normally provide finance for short term needs of the
firms.
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Venture capital provides funds in the form of equity to new projects which
involve some innovative ideas.
External Risk :
A bank may fail to honour the deposit claims of the deposit holders if the
non-performing assets of the bank are above its net worth.
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(ii)
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Another important external reason for the failure of these institutions in the
business of lending is the quality of other assets in their total assets. If the
investment is made in high-risk debt or equity securities, any adverse
development in the capital market or the issuing company or agency will
reduce the value of the investments and in this process it may affect the
bank's ability to meet the liability.
Insurance Services : Insurance services take the risk associated with the
assets of their clients. The premium collected for this service in turn is either
invested in securities or led to outsiders who are in need of money.
External Risk :
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Similarly, the quality of assets they have insured may also turn bad.
(b)
Stock Broking Services : Stock Brokers but and sell on behalf of their clients.
They collect the securities from the sellers and collect money from the buyer and
hand over the funds to seller after deducting the brokerage for the service
rendered.
(iii)
(a)
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External Risk : Though the activity looks relatively simple, the risk from external
sources are very high:
(iv)
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First, in situation where the trades are not guaranteed by the stock
exchanges.
There is always a possibility that the client may fail to honour the
commitment but the broker has to make good the loss.
Leasing and Hire Purchase : Leasing and Hire Purchase service is very close
to the banking service. These companies also raise money from the market
through deposits and other means and lend to industries. Of course, the lending
is done not in the form of term loan or working capital loan, but in the form of
assets.
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(v)
External Risk : Leasing and hire purchase companies are also affected by the
frequent changes in the regulations. The recent Reserve Bank of India
regulation is expected to wipe out many of these companies from the market as
RBI has put rigid norms in raising deposits from the public.
External Risk :
First and foremost among them is the quality of evaluation of the loan
proposals. Often, the appraising officers fail to consider vital issues that
affect the outcome of the project.
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(2)
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Receipt of documents or cash from the clients and delivery of cash or
documents to the clients.
Internal Risk :
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Even if the stocks delivered are good and genuine, there is no guarantee
that they are good for delivery.
Many Indian stock brokers have also trade on their account and their
proximity with the trading system does not guarantee profit. On several
occasions, many big brokers have incurred huge losses on their trading.
(iv)
Leasing and Hire Purchase : The business of leasing and hire purchase is
highly competitive with too many players in the market.
Internal Risk :
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First the credit rating information in India is relatively weak and published
accounts are not reliable to assess the credit worthiness of the borrowers.
Secondly, the competition in the industry allows very little time to take
decision on sanctioning the proposals, otherwise, the competitors will
take away your clients.
Internal Risk :
On the other hands, if they freely use the information to their own benefit, it
hurts the performance of the funds.
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Types of Risk : In the previous section, the different source of risk for various financial
services firms have discussed. They could now broadly be classified under the following six
heads:
1.
Credit Risk : Many of the financial services firms like banking, credit cards, lease and
hire purchase are also involved in fund based business. The credit risk affects the fund
based activities of the financial services. The risk arises in evaluating the proposals for
lending. While credit rating, either by credit rating institutions or internally helps to
quantify the risk, the percentage of non-performing assets measurers the impact of
credit risks in the firms.
2.
Asset-Liability Gap Risk : This risk also applies to firms doing fund based services.
Since funds raised from external sources play a major role in the fund based activities,
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4.
Interest Rate Risk : This risk affects the firms which are in fund based activities. The
interest rate risk arises when there are frequent changes in the interest rates in the
market.
5.
Market Risk : Financial services firms which are in the investment business or
investing a part of the funds in securities are exposed to the market risk. This risk
arises on account of changes in the economy and all securities are affected.
6.
Currency Risk : Firms which are dealing in foreign exchange currencies are exposed
to this source of risk. Bank, financial institutions and money changers are few financial
services firms which are normally affected by this source of risk. This risk arises
because of changes in the currency values which in turn was determined by the
fundamental economic strength of the two countries and short run demand and supply
gap. These firms are affected by currency risk when they hold currencies or liabilities
in the form of either forward contract or interest/principal payment.
(i)
When the Rupee depreciates, it affects those who are holding foreign currency
liabilities.
(ii) When the Rupee appreciates, if affects those who are holding foreign currency.
Q.
Explain how you can manage the risk involved in Financial Services.
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Ans. Introduction : It may not be feasible to start any venture without taking risk. Risk is an
integral part of any business and the reward or profit is directly proportional to the risk
undertaken. In the case of financial services industry, the firms deals with financial claims
which are by nature risk products. We will now discuss different strategies available to
manage these risks:
Management of Risk :
(1)
Managing Credit Risk : The first step in the process of managing the credit risk is the
quantification of credit risk the firm is exposed. The quantification is done through
credit rating. The firm can adopt the following strategy in managing the credit risk. The
steps involved in this strategy are:
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(ii)
(iii)
Action on Doubtful and Bad Debts : The moment the monitoring system
raises some doubts about the loan account, action need to be initiated to
recover the loans. The steps are:
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Managing Asset-Liability Gap Risk : This risk also applies to firms doing fund based
services. Since funds raised from external sources play a major role in the fund based
activities, the duration of the liability is an important variable which needs to be
considered while lending. For example, if a firm gives a five year loan against a
deposit for two years, there is a mismatch between the liability and asset. The
techniques of management are:
(2)
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(i)
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(3)
Gap Management: The first job in the ALM is to measure gap. There are two
ways in which the gap can be measured. If the gap is measured at a macro level,
it has limited use. It given an idea about the level of risk involved in the firm. The
second method which is useful in ALM is to get a detailed break up of 'Gap'. The
gap has to be necessarily closed or managed.
(4)
Managing Interest Rate Risk : Interest rates in the economy play a major role in the
financial markets. For managing interest rate risk interest rate swap is adopted.
Interest Rate Swap : Interest rate swap involves the exchange of interest payments.
It usually occurs when a person or a firm needs fixed rate funds but is only able to get
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floating rate funds. It finds another party who needs any floating rate loan but is able to
get fixed rate funds. The two, known as counter parties, exchange the interest
payments and the loans according to their own choice. It is the swap dealer, usually a
bank, that brings together the two counter-parties for the swap.
Managing Market Risk : This is the minimum risk that investors in the market are
exposed. Firms which are investing in the securities have to manage the market risk.
There are several ways through which the market risk is managed. Some firms take a
view on the market and switch over the funds from one market to another in order to
minimize the risk.
(6)
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(5)
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UNIT II
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Ans. Meaning of Stock Exchange : Stock exchange means an organized market where
securities issued by companies, government organizations and semi-organizations are sold
and purchased. Securities include:
(i)
Shares
(ii) Debentures
(iii) Bonds etc.
Definition of Stock Exchange :
According to Pyle :
Stock Exchange are market places where securities that have been listed thereon,
may be bought and sold for either investment or speculation.
Features of Stock Exchange : The main features of stock exchange are as follows:
Organised Market : Stock Exchange is an organized market. Every stock exchange
has a management committee, which has all the rights related to management and
control of exchange. All the transactions taking place in the stock exchange are done
as per the prescribed procedure under the guidance of management committee.
(2)
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(1)
(3)
Dealing only through Authorized Members : Investors can sale and purchase
securities in stock exchange only through authorized members. Stock exchange is a
specified market place where only the authorized members can go. Investor has to
take their help to sale and purchase.
(4)
Necessary to obey the Rules and Bye-Laws : While transacting in stock exchange,
it is necessary to obey the rules and bye-laws determined by stock exchange.
Functions of Stock Exchange : The main functions performed b stock exchange are as
follows:
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(2)
(3)
Safety of Transactions : Stock exchanges are organized markets. The fully protect
the interest of investors. Each stock exchange has its own laws and be-laws. Each
member of stock exchange has to follow them and any member found violating them,
his membership is cancelled.
(4)
(5)
Spreading Equity Cult : Share market collects every types of information in respect
of the listed companies. Generally this information is published or otherwise n case of
need anybody can get it from the stock exchange free of any cost. In this way, the stock
exchange guides the investors by providing various types of information.]
(6)
Providing Scope for Speculation : When securities are purchased with a view to
getting profit as a result of change in their market price, it s called speculation. It is
allowed or permitted under the provisions of the relevant Act. It is accepted that in
order to provide liquidity to securities, some scope for speculation must be allowed.
The share market provides this facility.
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(1)
Stock Exchange in India : There are 24 stock exchanges functioning currently in India. The
names are given below:
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Q.
What are the main features of NSEI? Explain the trading process of NSEI
Ans. National Stock Exchange of India (NSEI) : The NSEI has been established in the
form of a traditional competitor stock exchange. It is an exchange where business is carried
on in the securities of the medium & large-sized companies & the government securities.
This stock exchange is fully computerized.
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The NSEI was established in the form of a public limited company in Nov., 1992. Its
promoters are like this:
(i)
The Industrial Development Bank of India (IDBI).
(ii) The Industrial Finance Corporation of India (IFCI).
(iii) The Industrial Credit & Investment Corporation of India (ICICI).
(iv) The Life Insurance Corporation of India (LIC).
(v) The General Insurance Corporation of India (GIC).
(vi) The SBI Capital Market Limited.
(vii) The Stock Holding Corporation of India Ltd.
(viii) The Infrastructure Leasing & Financial Services Ltd.
Features or Nature of NSEI : The Chief features of the NSEI are following:
Model Exchange : The NSEI is the first stock exchange of its kind. The system of
transaction of securities is very efficient and transparent. It is, therefore called a model
exchange.
2)
Floorless : In the NSEI there is no special importance of trading. The terminals of the
NSEI have been established almost throughout the country.
3)
Two Segments : On the basis of the transactions of securities done on the NSEI, it
can be divided into two parts:
(i)
Wholesale Debt Market (WDM): This can be called money market segment. It
mai9nly concerns the government securities, bonds of public sector
undertakings, treasury bills, commercial papers, certificates of deposits, etc.
(ii)
Capital Market Segment: Its concern is with the shares and debentures of
companies.
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4)
1)
and small
5)
Transparency in Transactions : Anybody can visit the local terminal of the NSEI
and have a look at various transactions of the securities. Therefore is no possibility of
any fraud in transactions.
6)
Competition : The NSEI has removed the shortcomings of the traditional share
markets and it has attempted to provide better facilities to the investors. Thats why the
remaining share markets are nervous at its success. Now, they are also trying to
provide good facilitate to the investors. In this way, there is a competition between two
kinds of share markets. The investors are getting the benefits of this competition.
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8)
Listing of other Stock Exchange : The securities of those companies which have not
been listed on other share markets can be traded on the NSEI.
9)
10)
Order Driven System : The NSEI is a stock exchange based on the order driven
system. It means that the sellers and buyers first place the order about the type of
security, its number, rate and time when they are ready to buy or sell them. On the
receipt of this order on the computer, the process of order matching starts. The
moment a good matching takes place, its information appears on the computer
screen.
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7)
Purposes of NSEI :
The chief aims of the establishment of the NSEI are the following:
Single Stock Exchange at National Level : It was decided by a Shri M.J. Pherwani
that there should be a single stock exchange at the National level so that the
confidence of the investors in the capital market increases.
2)
Increasing Numbers of Transactions : For the last few decades, there has been an
increase in the numbers of investors while the stock exchange system continues to be
old. In such a situation the transactions cannot be settled easily. The purpose of the
establishment of the NSEI is to solve this problem.
3)
Decreasing Liquidity : There is a decline in the liquidity of the securities under the
system of local stock exchange because the people doing transaction on a single
stock exchange are limited in number. On the contrary, through the medium of NSEI
the investors from the entire country can trade simultaneously at a single stock
exchange. This increase the liquidity of securities. Therefore, the purpose of the NSEI
is to check the decreasing liquidity of securities.
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4)
1)
5)
Developing a Debt Market : The purpose of the NSEI is to develop a debt Market. In
the traditional share market, transactions are mostly in shares and no attention is paid
to Debentures. Now the NSEI has divided the market in two parts-Debt market and
capital Market. Therefore, this division is helpful in the development of debt market.
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Trading Process on NSEI : The selling and buying process of securities on the NSEI is as
under:
Placing the Order : First of all the person buying or selling securities places an order.
In this order, he tells the name of the company whose security he is ready to buy or sell
at what price, in what quantity and for what period of time.
2)
Conveying the Message to Computer : The moment the terminal operator receives
the order from the customer, he feeds it in the computer.
3)
Starting of Matching Process : The moment the computer receives orders, it starts
the process of matching. During the process of matching orders, the best matching of
the selling or buying order is sought to be found out.
4)
Accepting the Order : As soon as the best matching of the buying and selling orders
is established during the process of matching orders, its list is immediately obtained on
the computer screen. This information tells us at what rate, time. All the terminals of the
NSEI established throughout the country go on feeding their computers continent with
what party your order has been transacted.
5)
Delivery and Payment : After the transaction has been settled, the delivery and
payment are made according to the rules of the NSEI.
Q.
What are the main features of OTCEI? Explain the trading process of OTCEI.
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Ans. Over the Counter Exchange of India (OTCEI) : The OTCEI is a completely
computerized and special ringless stock exchange which is different from the traditional
stock exchange and on which the buying and selling of securities is absolutely transparent
and moves at a great speed. Its counters are spread all over the country where transactions
are made with the help of telephone.
The OTCEI was established under section 25 of the Companies Act, 1956 in October, 1990.
The promoters of the OTCEI are the following financial and other institutions:
(i)
The Unit Trust of India
(ii) The Industrial Credit and Investment Corporation of India.
(iii) The Industrial Development Bank of India
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(iv)
(v)
(vi)
(vii)
(viii)
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Features or Nature of OTCEI : The main features of the OTCEI are the following:
(2)
Nation Network : The OTCEI has its network all over the country. All the counters are
linked with the central terminal through the medium of computers. Therefore, the
facility of nationwide listing is available here. In other words by listing on one
exchange, one can have transactions with all the counters in the whole country.
(3)
Exclusive List of Companies : On the OTCEI only those companies are listed whose
issued capital is 30 lakhs or more. In the old share markets this amount used to be ten
crores on the BSE and three crores on the other exchanges and hence, listing was not
possible in case the issued capital was less than three crores. Those companies
which have been listed on the old share markets cannot be listed on the OTCEI.
(4)
Fully Computerized : This exchange is fully computerized. It means that all the
transactions done on this exchange are done through the medium of computers.
(5)
Sponsorship : In order to get listed on the OTCEI, a company has to find a member to
sponsor it. The main job of a sponsor is market making. T means a sponsor has to be
read to buy or sell the shares of that company at least for a period of 18 months. In this
way, a sponsor creates liquidity in securities.
(6)
Investors Registration : All the investors doing transactions on the OTCEI have got
to register themselves compulsorily. Registration can be got done b giving an
application at an counter. The registration is called the INVESTOTC CARD. On the
basis of this card, one can do transactions of securities at any counter throughout the
country.
Greater Liquidity : There is greater liquidity in securities because of the sponsors job
of market making.
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(7)
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(1)
(8)
Transparency in Transactions : All the transactions are done in the presence of the
investor. The rates of buying and selling can be seen on the computer screen. The
operator cannot do any fraud or mischief with the transactions.
(9)
Faster Delivery and Payment : On the OTCEI, delivery in case of buying and
payment in case of selling are both very fast. The work of delivery and payment in case
of listed securities and permitted securities is completed within seven days and 15
days respectively.
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(10) Two ways of Public Offer : A company listed on the OTCEI can issue security in two
ways. Firstly, the company can go directly to the public. This is called Direct Offer
System. Secondly, the company sells its securities to the sponsor at a particular price.
Then the sponsor sells them to the public. This is called Indirect Offer System.
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(11) Easy Access : In the big cities the counters of the OTCEI can be seen like ordinary
shops. Any body can go the counter and do buying and selling of securities.
Trading Process : One can trade in securities b going to any counter of the OTCEI. All the
counters are linked with the central computer at the OTCEI headquarter. This office is in
Mumbai. There can be three types of trading on the OTCEI:
Initial Allotment : When an investor is allotted shares through the medium of OTCEI,
he is given a receipt which is called counter receipt-CR. This receipt is just like the
share certificate. Selling and buying can be done through the medium of this receipt.
(2)
Buying in the Secondary Market : For the purpose of buying shares listed on the
OTCEI, a person has to get himself registered (if he is not already registered). After
this, he informs the counter operator about the number of the shares to be purchased.
The counter operator displays the rates on the screen. After getting himself satisfied
with the rate, the investor hands over the cheque to the operator. On the encashment
of the cheque, the CR is handed over to the investor. This procedure takes about a
week.
(3)
Selling in the Secondary Market : An investor who has purchased shares from the
OTCEI can sell his shares at any counter of the OTCEI. After getting himself satisfied
with the rate displayed on the screen, the investor hands over the Counter Receipt and
the Transfer Deed to the Operator. The operator prepares the Sales Confirmation Slip
(SCS) and a copy of it is handed over to the seller. The operator sends the CR, TD and
SCS to the Registrar for confirmation. After confirming every detail the Registrar sends
them back to the counter operator. In the end the operator issues a cheque to the seller
and receives back the SCS from the seller.
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(1)
Purposes of OTCEI : The objects of the establishment of the OTCEI may be described as
under:
Liquidity : The first object for the establishment of the OTCEI is o maintain liquidity in
the securities of the small companies. The sponsor has got to do the job of market
making.
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(1)
(2)
(3)
(5)
(6)
Access : This stock exchange is of the ringless type and therefore, has its counters all
over the country.
Q.
Write brief notes on the concept of mutual funds. Also explain the
organizational functions of mutual funds.
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(4)
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Investors
Working of a Mutual Fund : The flow chart below describes broadly the working of a
mutual fund :
Passed back to
Pool their
money with
Fund
Manager
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Returns
Generates
Invest in
Securities
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Mutual Fund Organisation : There are many entities involved and the diagram below
illustrates the organization set up of a mutual fund:
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Sponsors
Unit Holders
AMC
Trustees
Transer Agent
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Custodian
SEBI
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A mutual fund can be constituted either as a corporate entity or as a trust. In India, UTI was
set up as a corporation under an Act of parliament in 1964. Indian banks when permitted to
operate mutual funds, were asked to create trusts to run these funds. A trust has to work on
behalf of its trustees. Indian banks operating mutual funds had made a convincing plea
before the government to allow their mutual funds to constitute them as Asset Management
Companies. The department of Company Affairs, Ministry of Law, Justice and Company
Affairs has issued guidelines in respect of registration of Assets Management Companies
(AMCs) in consultation with SEBI, as follows:
(1)
Approval of AMC by SEBI : As per guidelines, AMC shall be authorized for business
by SEBI on the basis of certain criteria and the Memorandum and Articles of
Association of the AMC would have to be approved by SEBI.
(2)
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(ii)
(iii)
(iv)
(v)
Custodian : A custodian is again a corporate body that carries out the following
functions:
Holds Securities
(vi)
Fund Administrator
Legal Advisors.
Fund Officers
Underwriters/Distributors
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(i)
Q.
What are the advantages of investing in mutual funds? Also explain the
drawbacks of mutual funds.
(2)
(3)
Liquidity : Its easy to get your money out of a mutual fund. Write a cheques, make a
call and youve got the cash.
(4)
Convenience : You can usually buy mutual fund shares by mail, phone or over the
Internet.
(5)
Low Cost : Mutual fund expenses are often no more 1.5 % of your investment.
(6)
(7)
Capital Appreciation
(8)
(9)
Even the smallest dividend or capital gain gets reinvested, thus enhancing the
effective return.
(11) Transparency
(12) Flexibility
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(1)
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(1)
(2)
Fees and Commissions : All funds charge administrative fees to cover their day-today expenses. Some funds also charge sales commissions or loads to compensate
brokers, financial consultants, or financial planners.
(3)
Taxes : During a typical year, most actively managed mutual funds sell anywhere from
20 to 70% of the securities in their portfolios. If your fund makes a profit on its sales,
you will pay taxes on the income you receive, even if you reinvest the money you
made.
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Q.
What are the different types of mutual funds schemes? Also explain the types of
mutual fund schemes in India.
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(4)
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Types of Mutual Fund Schemes : A wide variety of mutual fund schemes exists to cater to
the needs such as financial position, risk tolerance and return expectations etc.
Types of Mutual Fund Schemes
By Investment
Objectives
By Structure
Growth Funds
Income Funds
Balanced Funds
Area Funds
By Structure : On the basis of structure, there are two types of mutual fund schemes:
(1)
Open-ended Funds : In open-ended funds, there is not limit to the size of funds.
Investors can invest as and when they like.
(2)
Close-ended funds : These funds are fixed in size as regards the corpus of the
fund and the number of shares. In close-ended funds, no fresh units are created
after the original officer of the scheme expires.
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(A)
Open-ended Funds
Close-ended Funds
Other Schemes
(B)
Growth Funds : These funds do not offer fixed regular returns but provide
substantial capital appreciation in the long run. The pattern of investment in
general is oriented towards shares of high growth companies.
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(3)
(4)
Area Funds : These are funds that are raised on other countries for providing
access to foreign investors. The India Growth Fund and the India Fund raised in
the US and UK respectively are examples of area funds.
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Income Funds : These funds offer a return much higher than the bank deposits
but with less capital appreciation. The emphasis being on regular returns, the
pattern of investment in general is oriented towards fixed income-yielding
securities like non-convertible debentures of consistently good dividend paying
companies etc.
Other Schemes :
(1)
Tax Saving Funds : These funds are raised for providing tax relief to those
investors whose income comes under taxable limits.
(2)
Special Funds : These funds are invested in a particular industry like cement,
steel, jute, power or textile etc. These funds carry high risks with them as the
entire fund is exposed to a particular industry.
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(C)
(2)
(1)
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(vi)
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(iv)
(v)
(4)
Tax Planning Schemes : The investment made under these schemes are deductible
from the taxable income up to certain limits, thus providing substantial tax relief to the
investors.
Examples of tax planning schemes:
(a) Can 80CC and Canstar 80L of Canbank Mutual Fund
(b) Ind 88A of Indbank Mutual Fund
(5)
Other Schemes : These include schemes of 10-15 years duration, which offer
multiple benefits. For example:
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(3)
Sr. No.
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1.
2.
Scheme
Benefits
(i)
(ii)
(iii)
(iv)
(v)
Dhanaraksha,
Dhansahyog,
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(i)
(ii)
(iii)
Dhanavridhi
Q.
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Schemes of LIC
Mutual Fund
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Ans. Merchant Bankers : A merchant banker is any person who is engaged in the business
of issue management either by making arrangements regarding selling, buying or
subscribing to securities or acting as manager/consultant/advisors or rendering corporate
advisory service in relation to such issue management. Issues mean an offer for
sale/purchase of securities by any body corporate/other person or group of persons through
a merchant banker. The importance of merchant bankers as sponsors of capital issues is
reflected in their major services such as, determining the composition of capital structure,
draft of prospects and application forms, listing of securities and so on. In view of the
importance of merchant bankers in the process of capital issues, it is now mandatory that all
public issues should be managed by merchant bankers functioning as the lead managers. In
the case of right issues not exceeding Rs. 50 lakh, such as appointments may not be
necessary.
Issue Management :
(i)
The evaluation of the clients fund requirements and evolution of a suitable
finance package.
(ii) The design of instrument such as equity, convertible debentures, nonconvertible debentures etc.
(iii) Applications covering consents from institutions/banks and audited certificates,
etc.
(iv) Appointment of agencies such as printers, advertising agencies, registrars,
underwriters, and brokers to the issue.
(v) Preparation of prospectus
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(2)
(1)
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(4)
(5)
Q.
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(3)
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(2)
Rights Issue : Right issues are issues of new shares in which existing shareholders
are given preemptive rights to subscribe to new issue of shares. Such further shares
are offered in proportion to the capital paid-up on the shares help by them at the date of
such offer. The shareholders to whom the offer is made are not under any legal
obligation to accept the offer.
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(3)
(1)
Q.
Ans. Introduction : raising money from the capital market needs planning the activities and
chalking out a marketing strategy. It is, therefore, essential to make an nalaytical study of
various sources, the quantum, the appropriate time, the cost of raising capital and the
possible impact of such resources on the overall capital structure besides the low governing
the issue. There are various activities required for raising funds from the capital markets.
These can be broadly divided into pre-issue and post-issue activities.
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Pre-issue Activities :
(1)
(2)
(3)
(4)
(5)
(6)
Due Diligence : The lead manager while preparing the offer document is required to
exercise utmost due diligence and to ensure that the disclosures made in the draft
offer document are true, fair and adequate.
(7)
Submission of Offer Document to SEBI : The draft document thus prepared is filed
with SEBI along with a due diligence certificate to obtain their observations. SEBI is
required to give its observations on the offer document within 21 days from the receipt
of the offer document.
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(A)
(8)
(9)
Filing with RoC : After incorporating SEBI observations in the offer document, the
complete document is filed with Registrar of Companies to obtain their
acknowledgment.
(10) Launching of a Public Issue : The observation letter issued by SEBI is valid for a
period of 365 days from the date of its issuance within which the issue can open for
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subscription. Once the legal formalities and statutory permission for issue of capital
are complete, the process of marketing the issue starts. Lead manager has to arrange
for distribution of public issue stationery to various collecting banks, brokers, investor ,
etc. The announcement regarding opening of issue in the newspapers is alos required
to be made by advertising in newspapers 10 days before of the issue opens.
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(11) Promoters Contribution : A certificate to this effect that the required contribution of
the promoters has been raised before opening of the issue obtained from a chartered
accountant is also required to be filed with SEBI.
(12) Closing of the Issue : During the currency of the issue, collection figures are also
obtained on daily basis from Bankers to the issue. These figures are to be filed in a 3
days report with SEBI. Another announcement through the newspapers is also made
regarding the closure of the issue.
Post-Issue Activities : After the closures of the issue, lead manager has to manage
the post-issue activities pertaining to the issue. Certificate of 90% subscription from
Registrar as well as final collection certificate from Bankers are obtained.
(1)
(2)
(3)
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(B)
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UNIT III
Q.
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Define Leasing. What are its essential elements? Discuss briefly the
significance and limitations of leasing.
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Parties to the Contract : There are essentially two parties to a contract of lease
financing, namely:
(i)
The Owner called the lessor
(ii) The User called the lessee
(1)
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(2)
(3)
Ownership separated from User : The essence of a lease financing contract is that
during the lease-tenure, ownership of the asset vests with the lessor and its use is
allowed to the lessee. On the expiry of the lease tenure, the asset reverts to the lessor.
(4)
Term of Lease : the term of lease is the period for which the agreement of lease
remains in operation. Each lease should have a definite period otherwise it will be
legally inoperative.
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(6)
Modes of Terminating Lease : The lease is terminated at the end of the lease period
and various courses are possible, namely,
(i)
The lease is renewed on a perpetual basis for a definite period, or
(ii) The asset reverts to the lessor, or
(iii) The asset reverts to the lessor and the lessor sells it to a third party, or
(iv) The lessor sells the asset to the lessee.
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(5)
Advantage to the Lessee : Lease financing has following advantage to the lessee:
(1)
Financing of Capital Goods : Lease financing enables the lessee to have finance for
huge investments in land, building, plant, machinery, heavy equipments and so on,
upto 100 percent, without requiring any immediate down payment.
(2)
(3)
Less Costly : Leasing, as a method of financing, is less costly than other alternatives
available.
(4)
(5)
(6)
(7)
Tax Benefits : By suitable structuring of lease rentals, a lot of tax advantage can be
derived. If the lessee is in a tax paying position, the rental may be increased to lower
his taxable income. If the lessor is in tax paying position, the rentals may be lowered to
pass on a part of the tax benefit to the lessee. Thus, the rentals can be adjusted
suitably for postponement of taxes.
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(A)
(8)
Obsolescence Risk is averted : In a lease arrangement, the lessor being the owner
bears the risk of obsolescence and the lessee is always free to replace the asset with
latest technology.
(B)
(1)
Full Security : The lessor's interest is fully secured since he is always the owner of the
leased asset and can take repossession of the asset if the lessee defaults.
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Tax Benefit : The greatest advantage for the lessor is the tax relief by way of
depreciation. If the lessor is in high tax bracket, he can assets high depreciation rates
and , thus reduce his tax liability substantially.
(3)
High Profitability : The leasing business is highly profitable since the rate of return is
more than what the lessor pays on his borrowings.
(4)
High Growth Potential : The leasing industry has a high growth potential. Lease
financing enables the lessees to acquire equipment and machinery even during a
period of depression, since they do not have to invest any capital. Leasing, thus,
maintains the economic growth even during recessionary period.
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(2)
(2)
Loss of Residual Value : The lessee never becomes the owner of the leased asset.
Thus, he is deprived of the residual value of the asset and is not even entitled to any
improvement done by the lessee or caused by inflation or otherwise, such as
appreciation in value of leasehold land.
(3)
Consequences of Default : If the lessee defaults are complying with any terms and
conditions of the lease contract, the lessor may terminate the lease and take over the
possession of the leased asset.
(4)
Understatement of Lessee's Asset : Since the leased assets do not form part of
lessee's assets, there is an effective understatement of his assets.
(5)
Double Sales-tax : With the amendment of sale-tax law of various states, a lease
financing transaction may be charged to sales-tax twice- once when the lessor
purchases the equipment and again when it is leaded to the lessee.
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Q.
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(1)
(1)
(2)
Operating Lease : According to the IAS-17, an operating lease is one which is not a
finance lease. In an operating lease, the lessor does not transfer all the risks and
rewards incidental to the ownership of the asset and the cost of the asset is not fully
amortised during primary lease period. The lessor provides services attached to the
leased asset, such as maintenance, repair and technical advice. Operating lease is
generally used for computers, office equipments, automobiles, trucks, some other
equipments, and so on.
(B)
(1)
Sale and Lease Back : In a way, it is an indirect form of leasing. The owner of an asset
sells it to a leasing company (lessor) which leases it back to the owner (lessee).
(2)
Direct Lease : In direct lease, the lessee, and the owner of the asset are two different
entities. A direct lease can be of two types:
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(A)
Bipartite Lease : There are two parties in the lease transaction, namely (i) Asset
Supplier-cum-lessor and (ii) Lessee
Single Investor Lease : There are only two parties to the lease transaction- the lessor
and the lessee. The leasing company (lessor) funds the entire investment by an
appropriate mix of debt and equity funds.
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(1)
(C)
Tripartite Lease : Such type of lease involves three different parties in the lease
agreement: supplier, lessor and lessee.
(2)
Leveraged Lease : There are three parties to the transaction- (i) Lessor, (ii) Lender
(iii) Lessee. In such type of lease, the leasing company buys the asset through
substantial borrowing.
(D)
(1)
International Lease : If the parties to the lease transaction are domiciled in different
countries, it is known as international lease. This type of lease if further sub-classified
into
Import Lease : In an import lease, the lessor and the lessee are domiciled in the
same country but the equipment supplier is located in a different country. The
lessor imports the asset and leases it to the lessee.
Cross-border Lease : When the lessor and the lessee are domiciled in different
countries, the lease is classified as cross-border lease. The domicile of the
supplier is immaterial.
Q.
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(2)
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Ans. RBI NBFCs Directions : With a view to coordinate, regulate and control the
functioning of all non-banking financial companies, the RBI issues directions from time to
time under the RBI Act. They apply to leasing and hire-purchase companies as well.
Other Acts /Laws : The other acts/laws applicable to the NBFCs are:
(i)
Motor Vehicles Act : the lessor is regarded as a dealer and although the legal
ownership vests in the lessor, the lessee is regarded as the owner for purposes
of registration of the vehicle under the Act and so on. In case of vehicle financed
under lease, the lessor is treated as a financier.
(ii) Indian Stamp Act : The Act requires payment of stamp duty on all
instruments/documents creating a right/liability in monetary terms. The
contracts for equipment leasing are subject to stamp duty which varies from
state to state.
(2)
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(1)
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Delivery and Re-Delivery : The clause specifies when and how the
equipment would be delivered to the lessee and re-delivered to the lessor
or expiry of the lease contract.
Period : This clause specifies that the lessee has to take the equipment
for his use on lease on the terms specified in the schedule to the
agreement. It also includes an option clause to the lessee to renew the
lease of the equipment.
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Lease Rentals : This clause specifies the procedure for paying lease
rentals by the lessee to the lessor at the rates specified in the schedule to
the agreement.
Use : This clause enjoins upon the lessee the responsibility for proper and
lawful usage.
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Q.
Applicable Law : This clause specifies the country whose laws would
prevail in case of a dispute.
Explain the accounting treatment for finance and operating leases by a lessor
and by a lessee and their disclosures in financial statements.
Ans. Accounting Treatment for Leasing : Accounting treatment for leasing is divided into
two parts:
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(A)
(B)
Accounting for Leases by a Lessee : Accounting for finance and operating leases
by a lessee and disclosures in their financial statements are given below:
(1)
Finance Lease : A finance lease should be reflected in the balance sheet of a lessee
by recording an asset and a liability at amount equal at the inception of the lease to the
fair value of the leased assets net of grants and tax credits receivable by the lessor; if
lower, at the present value of the minimum lease payments. In calculating the present
value of the minimum lease payments the lease factor is the interest implicit in the
lease, if this is practicable to determine.
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(A)
(2)
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A finance lease gives rise to a depreciation charge for the asset as well as finance
charge for each accounting period. The depreciation policy for leased assets should
be consistent with that for depreciable assets which are owned and the depreciation
charge should be calculated on the basis set out in the 'IAS-4:Depreciation
Accounting'.
Operating Lease : The charge to income under an operating lease should be the
rental expenses for the accounting period, recognized on a systematic basis that is
representative of the time pattern of the user's benefit.
(1)
Finance Lease : An asset held under a finance lease should be recorded in the
balance sheet not as property, plant & equipment but as a receivable, at an anount
equal to the net investment in the lease.
Operating Lease : Assets held for operating leases should be recorded as property,
plant & equipment in the balance sheet of the lessor.
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(2)
(B)
The depreciation of leased assets should be on a basis consistent with the lessor's
normal depreciation policy for similar assets and the depreciation charge should be
calculated on the basis set out in IAS-4: Depreciation Accounting.
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Ans. Tax Aspects of Leasing : The tax aspects of leasing pertain to both income-tax and
sales tax.
(A) Income Tax Aspects
(B) Sales Tax Aspects
Income Tax Aspects : Leasing , as a finance device, has tax implications for, and
offers tax benefits both to, the lessor and the lessee.
(1)
For Lessor : The main attraction of leasing device to the lessor is the deduction of
depreciation from his taxable income. The relevant provisions applicable to the
computation of the lessor's income, the tax rates and so on are summarized as
follows:
Taxability of Lease Rentals : the computation of taxable income of an
assessee under the provisions of the Income Tax Act, 1961 involves
computation under various heads of income which are aggregated and then
reduced by certain deductions. Calculation of Computation of Income are:
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(A)
---------------------------------------------____________
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Where leasing constitutes the business/main activity of the assessee (lessor), income from
lease rental is taxable under the head Income from Business or Profession. In other cases,
the income from lease is taxed as Income from Other Sources.
(ii)
Depreciation
Rent, taxes, repairs and insurance of the leased asset where such
expenditure is borne by the lessor.
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Bad Debts
Of Capital Nature
A Personal Expense.
(ii) Deductibility of Incidental Expenses : The lessee is normally required to bear
expenses associated with the leased asset such as repairs and maintenance,
finance charge and so on. These incidental expenses to the lease are allowed
as a deduction by the Income Tax Act from taxable income of the lessee.
(B)
Sales Tax Aspects : The legislative framework governing levy of sales tax consists of
the :
Central Sales Tax Act, 1957(CST): The CST deals with the levy and collection of
sales tax on the inter-state sale of goods only.
Sales Tax Acts: The tax on sale of goods within a state (Intra-state sale) is
governed by the provisions of the respective STAs.
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(2)
A lease normally has three important elements from the viewpoint of sales tax:
Purchase of Equipment : When purchase of an equipment by a lesser involves interstate sale, the transactions attracts the provisions of the CST according to which the
normal rate of sales tax (10 per cent) or the appropriate rate applicable to intra-state
purchase/sale of goods in the respective state, whichever is higher, is imposed.
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(i)
(ii)
Lease Rentals : Before 1982, there was no sales tax on lease rentals. The incidence
of sales tax on them was introduced by the Constitution Act, 1982. The provisions are:
Sales tax is payable on the annual taxable turnover (aggregate lease rentals) of
the lessor. The rates of tax vary between a minimum and maximum; they also
vary from state to state.
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Q.
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(iii)
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(2)
Once a suitably large portfolio of assets has been originated, the assets are analysed
as a portfolio and then sold or assigned to a third party, which is normally a special
purpose vehicle company ("SPV") formed for the specific purpose of funding the
assets. It issues debt and purchases receivables from the originator.
(3)
The administration of the asset is then subcontracted back to the originator by the
SPV. It is responsible for collecting interest and principal payments on the loans in the
underlying poolt of assets and transfer to the SPV.
The SPV issues tradable securities to fund the purchase of assets. The performance
of these securities is directly linked to the performance of the assets and there is no
resource back to the originator.
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(4)
(1)
(5)
The investors purchase the securities because they are satisfied that the securities
would be paid in full and on time from the cash flows available in the asset pool. The
proceeds from the sale of securities are used to pay the originator.
(6)
The SPV agrees to pay any surpluses which, may arise during its funding of the
assets, back to the originator. Thus, the originator, for all practical purposes, retains its
existing relationship with the borrowers and all of the economies of funding the assets.
(7)
As cash flow arise on the assets, these are used by the SPV to repay funds to the
investors in the securities.
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Originator
Special Vehicle
Creit Rating
of Securities
Investors
Subscription of
Securities
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Rating Agency
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Issue of Securities
Ancillary Service
Provider
Obligor
Structure
Originator : This is the entity on whose books the assets to be securitized exist. It sells
the assets on its books and receives the funds generated from such sale.
(2)
SPV : An issuer, also known as the SPV, is the entity, which would typically buy the
assets to be securitized from the originator.
(3)
(4)
Obligors : the obligors are the original debtors. The amount outstanding from an
obligor is the asset that is transferred to an SPV.
(5)
Rating Agency : Since the investors take on the risk of the asset pool rather than the
originator, an external credit rating plays an important role. The rating process would
assess the strength of the cash flow and the mechanism designed to ensure full and
timely payment by the process of selection of loans of appropriate credit quality, the
extent of credit and liquidity support provided and the strength of the legal framework.
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(1)
(6)
Administrator or Servicer : It collects the payment due from the obligors and passes
it to the SPV, follows up with delinquent borrowers and pursues legal remedies
available against the defaulting borrowers. Since it receives the installment and pays it
to the SPV, it is also called the Receiving and Paying Agent.
(7)
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Ans. Introduction : Housing is one of the basic human need of the society. It is closely
linked with the process of overall socio-economic development of a country. India, being a
highly populated country there is a great need and scope for the development of Housing
Sector. Unfortunately, for some reasons or the other, the housing sector in India has
remained underdeveloped in the past, however, it is hoped that there would be improvement
in the near future.
Organisation or Structure of Housing Finance in India :
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The setting up of the National Housing Bank marked the new era in housing finance as a new
fund-based financial service in the country. A large number of financial
institutions/companies in the public, private and joint sector entered in this field. For
example, Life Insurance Corporation of India and General Insurance Corporation came with
various schemes for finance the housing units. In 1970, Housing and Urban Development
Corporation (HUDCO) a wholly government owned enterprise, was set up with the objective
of housing and urban development as well as infrastructure development. The structure of
housing finance industry is presented in the following figure:
STRUCTURE OF HOUSE FINANCING INDUSTRY
Formal Sector
Informal Sector
Household Savings
Disposal of Existing Properties
Borrowings from friends, relatives
and money lenders, Etc.
Government
Central Govt.
State Govt.
Public Authorities
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Banking
Commercial Banks
Cooperative Banks
Other Banks
Non-Banking
Non-Banking Finance Companies (NBFCs)
Housing Finance Companies (HFCs)
Non-Banking Housing Finance Companies (NBHFCs)
Insurance LIC/GIC
Specialised Institutions HDFC
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Q.
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Home Loan Account Scheme of NHB : Home Loan Account Scheme initiated by
National Housing Bank (NHB) with an objective of encouraging individual to save
specifically for housing. The basic features of this scheme are:
(i)
Eligibility : Any Indian citizen who is not owing exclusively in his or her name, a
house/flat/apartment any where in India may open an account under this
scheme.
(ii) Contribution : The individual under this scheme is required to start a saving of a
minimum of Rs. 30 per month. The minimum period for which the savings must
be accumulated is five years to become eligible for loan under this scheme.
There is no upper limit on the amount to be saved under the scheme.
(iii) Interest on Deposit : The contribution under this scheme is entitled for interest
at the rate of 10 per cent per annum.
(iv) Default : If the contributor fails to deposit for a continuous period for 12 calendar
months, the original date of opening the home loan account is shifted forward by
the period of default.
(v) Withdrawals : Under this scheme the amount can be withdrawn only for
construction/buying a house or a flat only after the expiry of 5 years. The amount
can be withdrawn even if he/she does not avail of loan facility.
(vi) Eligibility of Loan : An account holder is eligible for housing loan on the
completion of the saving period. The quantum of the loan is based upon the builtup area which is as under:
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(A)
Ans. Housing Finance Schemes : Various institutions provide financial assistance to the
needy persons. For this, they have come out with various financing schemes with different
features for meeting the diversified needs of this sector. The various housing finance
schemes are :
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Built-up Area
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Loan Amount
Up to 50,000
50,001-1,00,000
1,00,001-2,00,000
Above 2,00,000
(i)
Home Saving Plan : This scheme is designed on the pattern of HLAS of NHB. The
basic objective of this scheme is to provide housing loan on the basis of savings of the
borrower. The scheme is open to individual as well as to individual jointly with a child or
spouse. In this scheme, the minimum savings period is 25 months, but a participant
can save up to a period of 7 years. The amount of loan granted would be equal to 70%
of the cost of the property and the balance 30% would be financed from the borrower's
savings. The maximum period of re-payment is normally 15 years. The basic feature
of this scheme is that whole amount collected through savings contributed by the
participant borrowers is kept separate and is not mixed with other funds raised by the
HDFC.
(ii)
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(B)
The amount of loan and rate of interest charged on some of the schemes offered by the
HDFC have been shown in the following table:
Amount of Loan
(Maximum) in Rs.
Sr. Scheme
No.
Max.
-------------------------
--------
--------
2.
5,00,000
10.5
16.5
3.
15.5
16.5
4.
Home Extensions
5,00,000 or 85%
16.5
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NRI Schemes
16.0
18.5
Schemes of LIC Housing Finance Ltd. : Various housing finance schemes of LIC
Housing Finance Ltd. are:
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(C)
1.
Sr. Scheme
No.
Amount of Loan
(Maximum)
Max.
1.
Griha Prakash
5,00,000 or 75%
12.5
16.5
2.
GrIha Shubh
12.5
19.0
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6.
7.
Jeewan Niwas
Jeewan Kutir
(D)
5,00,000
10,00,000
10,00,000 or 85% of cost
of property
5,00,000
2,00,000
15.0
19.0
15.0
12.5
12.0
17.0
15.5
GIC Housing Finance : The GIC Housing Finance Ltd. was set up in December 1989
by the General Insurance Corporation as its subsidiary company. The various
schemes are:
Amount of Loan
(Maximum)
1.
2.
3.
4.
5.
6.
5,00,000
10,00,000 or 75% of
the cost of property
As per Company
As per Company
3,60,000 or 70% of cost
50% of cost of property
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Sr. Scheme
No.
Interest Rate
in (%)
Min.
12.0
14.0
Max.
18.5
19.0
13.0
13.0
17.5
21.0
16.5
16.5
18.5
19.0
SBI Home Finance : The SBI Home Finance was established in 1988, as subsidiary
of the State Bank of India, to provide financial assistance for housing specifically in the
Eastern and North Eastern Regions of the country. Basic features are:
(i)
The SBI HF grants the house loans to individuals for construction of houses,
purchase of house/flat, repairs renovation, extension, alteration of the existing
houses.
(ii) The quantum of loan is maximum 10 lakh
(iii) The re-payment period ranges 5-20 years.
(iv) The rates of interest are subject to changes from time to time. It varies with the
size of loan, term of loan and purpose of the loan.
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(E)
12.5
17.0
12.5
Griha Dhara
Griha Lakshmi
Griha Jyoti
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3.
4.
5.
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Loan Amount
Up to 25,000
25,001-1,00000
1,00,001-5,00,000
5,00,001 and above
Repairs loan upto 30,000
Q.
(ii)
Project Analysis
(iii)
(iv)
Definitions :
According to L.M. Bhole
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Ans. Credit Rating : Credit rating is a grading service to investors which helps them in
reducing their risk. It provides a bird's eye-view on the credit quality or the instrument quality
of a particular credit instrument issued by a business house. It is a technique in which
relative ranking is provided to different instruments of a company on the basis of systematic
analysis of the strengths and weaknesses of them. This credit ranking is done on the basis
of:
(ii)
(iii)
Ratings are very useful to investors especially when the regulatory authority takes no
responsibility for those who raise funds.
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(iv)
(i)
(v)
The leading rating agencies play a vital role in evaluating sovereign ratings.
Functions of Credit Rating : The major functions of credit rating are as follows:
(i)
(ii)
(iii)
(ii)
Equity Rating: The rating of equity shares in the capital market is called equity rating
and it occupies the minimum share in the business of credit rating agencies.
(iii)
Commercial Paper Rating: It is mandatory on the part of a corporate body to obtain the
rating from credit rating agency before issuing commercial paper in the market. This is
known as commercial paper rating
(iv)
Borrowers Rating: This includes rating a borrower to whom a loan facility may be
sanctioned.
(v)
Sovereign Rating: This includes rating a country as to its credit worthiness, probability
to risk etc.
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(i)
Credit Rating Process : The steps involved in the credit rating process are as follows:
The rating process begins at the request of the company
2.
A team is formed with professionally qualified analysts who are well-versed with the
working of the particular industry in which the requesting company operates. The team
visits the company and make inspections of the operations first hand.
3.
The team conduct meetings with different levels of management including the chief
executive officer
4.
The team consults with a back-up team which has collected company's information
from other sources and prepares the report.
5.
The team forwards its reports to the internal committee consisting of senior executives
of credit rating agency.
6.
An open discussion between the team members and the internal committee takes
place to arrive at a rating.
Then the ratings are placed before an external committee consisting of respected and
eminent people unconnected with credit rating agency to avoid any sort of biasness.
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7.
1.
8.
9.
The company may volunteer any further information at this point which could affect the
rating. This information is passed on to the external committee again for change or
affirmation of the previous ratings.
10.
The company may request the agency for review of the rating.
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Acceptance
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Drawbacks of Credit Rating Process : Rating Process has certain advantage but
simultaneously suffers from drawbacks also. These are:
1.
It does not take into account the factors, like market prices, personal risk or
reward preferences that might influence investment decisions.
2.
4.
The ratings are only the matters of opinion and not a recommendation to
purchase or sell or hold security.
5.
Credit ratings depend on both expertise and honesty of credit rating agencies.
Therefore, credit ratings may also serve to misguide the investors.
Most of the rating agencies do not give rating to equity are supposed to take risk
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Q.
3.
Explain briefly the credit rating methodology used by the rating agencies for
manufacturing and financial services companies.
Ans. Rating Methodology : The rating methodology involves an analysis of the industry
risk, issuer's business and financial risks. A rating is assigned after assessing all the factors
that could affect the credit worthiness of the entity. The rating methodology is illustrated
below with reference to
For Manufacturing Companies : The main elements of the rating methodology for
manufacturing companies are given below:
Business Risk Analysis : The rating analysis begins with an assessment of the
company's environment, focusing on the strength of the industry prospects,
pattern of business cycles as well as the competitive factors affecting the
industry. Business analysis is basically undertaken to analyse the risks involved
in the operations of the company. It includes:
(i)
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(ii)
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Interest and Tax Sensitivity : Exposure to interest rate changes, tax law
changes, hedging against interest rates and so on.
(i)
(ii)
Capital Adequacy : Assessment of the true net worth of the issuer, its adequacy
to the volume of business and the risk profile of the assets.
Profitability and Financial Position : Credit rating agency also analyses the
profitability and financial position of the company. For this, the rating agency
analyses the past profit, revenues on non fund based services, accretion to
reserve and so on.
Interest and Tax Sensitivity : Exposure to interest rate changes, tax law
changes, hedging against interest rates and so on.
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(2)
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Q.
Explain the Credit Rating Agencies in India. Also explain the rating symbols
used by credit rating agencies.
Credit Rating Information Services of India Ltd. (CRISIL Ltd.) : As the first credit
rating agency in India, the CRISIL was promoted in 1987 jointly by the ICICIA Ltd. and
the Unit Trust of India. Other shareholders include:
(i)
Asian Development Bank.
(ii) Life Insurance Corporation
(iii) HDFC Ltd
(iv) General Insurance Corporation
(v) Several Foreign and Indian Banks.
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Ans. Credit Rating Agencies in India : There are four credit rating agencies in India.
These are as follows:
1.
CRISIL Ltd.
2.
ICRA Ltd.
3.
CARE Ltd.
4.
FITCH Ltd.
It commenced operation on January 1, 1988. It offered its share capital to the public in 1993.
Its objective is to rate the debentures, fixed deposits, short term borrowing instruments and
preference shares of the companies on request from them. The CRISIL ratings are now
required by the authorities, banks, UTI, merchant bankers, etc. in the due course of assisting
companies. CRISIL is also publishing the corporate news regularly, containing information
on their financial, business and technical aspects.
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Objectives of CRISIL :
(i)
To assist both individual and institutional investors in making investment decisions in
fixed interest securities.
(ii) To enable companies to mobilize funds in large amounts from a wide investor base, at
a fair cost.
(iii) To enable intermediaries to place debt instruments with investors by providing them
with an effective marketing tool.
(iv) To provide regulators with a market-driven system for bringing about discipline and a
healthy growth of capital markets.
To achieve these objectives, the functions performed by the CRISIL currently fall under four
broad categories:
(i)
Credit Rating Services
(ii) Advisory Services
(iii) Credibility first rating and evaluation services
(iv) Training Services
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Debenture Ratings :
Triple A - AAA
Highest Security
Double A -AA
High Safety
Single A - (A)
Adequate Safety
Triple B- BBB
Moderate Safety
Double B - BB
Inadequate Safety
High Risk
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Debenture Ratings
Rating Symbols and Investor Protection : Investors should also be familiar with the
ratings given by the CRISIL for protecting their interests. The CRISIL ratings are given only
for debt instruments of companies, commercial papers, debentures, bonds and fixed
deposits. The symbols and their implication used for ratings are as follows:
Substantial Risk
Default
Implications
F -Triple A - (FAAA)
Highest Safety
F -Double A -(FAA)
High Safety
Adequate Safety
F- Single B ( FB)
Inadequate Safety
F -Single A - (FA)
F- Single C (FC)
High Risk
F-Single D (FD)
Default
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Short-Term Instruments :
2.
P-1
Highest Safety
P-2
High Safety
P-3
Adequate Safety
P-4
Inadequate Safety
P-5
Default
Investment Information and Credit Rating Agency of India Ltd. (ICRA Ltd.) : ICRA
was incorporated on January 16, 1991 and launched its service on August 31, 1991. It
was formerly known as Investment Information and Credit Rating Agency of India Ltd.
The ICRA Ltd. Has been promoted by the IFCI Ltd as the main promoter to meet the
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(ii)
Banks
(iii)
(iv)
(v)
Exim Bank
(vi)
HDFC Ltd.
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(i)
requirements of the companies based in the northern parts of the country. Apart from
the main promoter, which holds 26 percent of the share capital, the other shareholders
are:
(ii)
To assist issuers in raising funds, from a wider investor base, in large amounts
and at a lower cost for highly rated entities
(iii)
(iv)
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(i)
Services provided by ICRA : It presently offers its services under three banners:
Rating Services
(ii)
Information Services
(iii)
Advisory Service
(i)
(ii)
(iii)
Power Companies
(iv)
Service Companies
(v)
Construction Companies
(vi)
Insurance Companies
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(i)
Telecom Companies
(x)
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Highest Safety
LAA+, LAA
High Safety
LA+, LA
Adequate Safety
LBBB
Moderate Safety
LBB+, LBB
Inadequate Safety
LB+, LB
Risk Prone
LC+, LC
Substantial Risk
LD
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LAAA
MD
MC+, MC
Highest Safety
High Safety
Adequate Safety
Inadequate Safety
Risk Prone
Default
A2+, A2
High Safety
A3+, A3
Adequate Safety
A1+, A1
Risk Prone
A5
Default
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A4+, A4
3.
Credit Analysis and Research Care (CARE Ltd.) : The CARE Ltd is a credit rating
and information services company promoted by the Industrial Development Bank of
India jointly with financial institutions, public/private sector banks and private finance
companies. It commenced its credit rating operations in October 1993 and offers a
wide range of products and services in the field of credit information and equity
research. Currently, it offers the following services:
(i)
Credit Rating : The CARE undertakes credit rating of all types of debt
instruments, both short term and long term.
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Advisory Services : The CARE provides advisory services in the areas of:
Securitisation Transactions
Municipal Finances
(iii)
(iv)
(v)
(vi)
Other Services :
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(ii)
CAR -1
CAR-2
CAR -4
CAR -5
CAR -3
FITCH Ratings India Ltd. : FITCH ratings are an international rating agency that
provides global capital market investors with the highest quality ratings and research.
FITCH rates entities in 75 countries and has some 1100 employees in more than 40
local offices worldwide. FITCH ratings provides ratings for financial institutions,
insurance corporates, sovereigns and Public finance markets worldwide. FITCH India
is a 100% subsidiary of FITCH group. It is the only international rating agency with a
presence on the ground in India.
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It is the only rating agency in India with the ability to issue ratings on both
domestic and international debt issuances.
FITCH ratings are quoted daily on the financial magazines in the public press
and in research publications.
2.
AA (ind)
A (ind)
BBB (ind)
BB (ind)
Speculative
B ( ind)
Highly speculative
C (ind)
D (ind)
Default
t C(ind)
t D(ind)
Speculative
Default
3.
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AAA (ind)
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Rating Symbols :
F 2+( Ind)
F 3 ( Ind)
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F 1+( Ind)
F 4 ( Ind)
Speculative
F 5 ( Ind)
Default
Key Indian Clients : The key Indian Clients of FICTH rating are as follows:
1.
3.
5.
7.
9.
11.
2.
4.
6.
8.
10.
12.
UNIT IV
Q.
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Define Venture Capital. What are the regulations of venture capital funds by the
SEBI
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Ans. Introduction : Venture capital implies long term investment generally in high risk
industrial projects with high reward possibilities. This investment may be at any stage of
implementation of the project between start-up and commencement production.
Expectation of higher gain motivates the investor to invest the funds in the risky venture
which generally utilize new technology with higher probability of failure than success. The
investor makes higher capital gains through appreciation in the value of such investment if
the new technology proves successful, leading the enterprise to grow.
Meaning of Venture Capital : Venture capital is equity, equity featured capital seeking
investment in new ideas, new companies, new products, new process or new services that
offer the potential of high returns on investment. It may also include investment in
turnaround situations.
Venture capital means start up and first stage financing and funding the expansion of
companies that have already demonstrated their business potential but do not have access
to the public securities markets or to credit oriented institutional funding sources.
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(viii) Venture capital investors are not directly involved in the management of the enterprise
but manage their own portfolio of investments.
(ix) Venture capital investor does not interfere in the day-to-day business affairs but
closely watches the performance of the business unit and keeps in close contact with
the entrepreneur to protect and enhance his investment.
(x) Venture capital funds need not be repaid in the course of business units, but it is
realized through the exit route.
SEBI Venture Capital Funds Regulations : According to these regulations, a VCF means
a fund setup as a trust/company which has dedicated pool of capital raised in the specified
manner and invests it in the specified manner. The main elements of the SEBI regulations
are discussed below:
All VCFs must be registered with SEBI and pay Rs. 1,00,000 as application fee and
Rs. 10,00,000 as registration fee for grant of certificate.
(2)
An applicant, whose application has been rejected by SEBI, would not carry on any
activity as a VCF.
(3)
In the interest of investors, SEBI can issue directions with regard to transfer of
records/documents/securities/disposal of investment relating to is activities as a VCF.
(4)
In order to protect the interest of the investors, it can also appoint any person to take
charge of the records/documents/securities including the terms and conditions of
such appointment.
(5)
(6)
Venture capital funds must disclose the investment strategy at the time of their
registration.
(7)
They cannot invest more than 25 per cent corpus of the fund in one venture capital
undertaking.
A VCF is not permitted to issue any document/advertisement inviting offers from public
for subscription/ purchase of any of its units.
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(8)
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(1)
(9)
The VCFs must maintain for a period of eight years, books of accounts which give a
true and fair picture of the state of their affairs.
(10) A VCF established as a company can be wound up in accordance with the provision of
the Companies Act.
Q.
Ans. Venture Capital Investment Process : Financing of a high tech project under
venture capital has following steps. They can be presented in the form of following diagram:
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Detailed Approval
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Sensitivity Analysis
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Preliminary Evaluation
Preliminary Evaluation : After the first stage is completed, the venture capital
investor normally discusses the investment plan for the project with banker.
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(2)
(1)
(3)
Detailed Approval : In addition to the close discussion with the management team, a
detailed appraisal of project is undertaken. If required, they may even consult experts
in the similar field to take a decision.
(4)
Sensitivity Analysis : The forecasted results of both sales and profits are tested and
analyzed. The risks and threats are evaluated by using sensitivity analysis, which
helps evaluate to predict the probable risks and returns associated wit the project.
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(6)
Monitoring the project and post investment support : The venture capitalist role
begins with financing the project. It is a general practice of investor to appoint and
executive director to have closer look into the project. He assists the project in
developing strategies, decision making and planning.
Q.
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Ans. Venture Capital Financing : The selection of investment is closely related to the
stages and type of investment. The stages of financing as differentiated in the venture
capital industry broadly fall into two categories :
Seed Capital
Expansion Finance
Turnarounds
Management BuyOuts
Early Stage Financing : This stage of financing is done to initiate the new project or
help the new technocrat who wishes to commercialize his research talents. The main
instruments used for such financial assistance would be in the form of equity
contribution, unsecured loans and optionally convertible securities. This stage of
venture capital financing consists of:
(A)
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(i)
The technology used in the project and possible threats of new technology
in the near future.
The total investment required to commercialize the product and the time
required to get suitable returns etc.
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Later Stage Financing : This stage of venture capital financing involves established
business which required additional financial support but cannot take recourse to
public issues of capital. It includes:
(i)
Expansion Finance : Expansion finance may be needed by the enterprise for
adding production capacity once it has successfully gained market share and
faces excess demand for the product. It is strategically executed to:
To establish warehouse.
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(B)
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(ii)
Q.
Ans. Structuring the Deal/Financial Instruments : The structuring of the deal refers to
the financial instruments through which venture capital investment is made. There are many
instruments:
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(2)
Debt Instruments : To ensure that the entrepreneur retains managerial control, debt
instruments are issued. They Includes:
(i)
Convertible Debt: This debt can be converted in to equity shares of the
company.
(ii) Non-Convertible Debt: This debt cannot be converted into equity shares of the
company.
(iii) Conditional Loan: This is a form of loan finance without any pre-determined
repayment schedule or interest rate. The suppliers of such loans recover a
specified percentage of sales towards the recovery of the principal as well as
revenue in a pre-determined ratio, usually 50:50. The charges on sales is known
as royalty.
(iv) Conventional Loans: These are modified to the requirements of venture capital
financing. They carry lower interest initially which increases after commercial
production commence. A small royalty is additionally charged to cover the
interest foregone during the initial years.
(v) Income Notes: These fall between the conventional and the conditional loans
and carry a uniform low rate of interest plus royalty on sales.
Q.
What are the important channels for exit of investment in venture capital
financing?
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Ans. Exit Routes : The main aim of the venture capitalist is to realize the investments with
huge profit after the completion of successful efforts with the promoter in launching or
commercializing the product. The exit route will be well thought by the investor at the stage of
making investments. There are four alternatives:
(1)
Initial Public Offer : Most of the venture capital assisted firms prefer to go in for public
issues to recover their investments with profits. The public issues provide another
opportunity for the company to list its shares in the stock market. Once the shares are
listed, the image of the company increases and attracts efficient persons to work in the
organizations, In addition to this, commercial banks and financial institutors
strategically come forward to offer different types of loans. If the firm wishes to raise
additional capital for expansion and growth, it could be done easily through the public
issue.
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Buy Back of Share by the Promoters : Sometimes, the promoter may prefer to have
exit route though Over The Counter Exchange Of India by entering into bought out
deals with the member of O.T.C. He may purchase the shares with a view to entering
into the primary market later.
(3)
(4)
Liquidation : This is a lender of last resort, when a firm performs very badly, on other
words if it incurs continuous cash loss over the years, the venture capitalist and the
entrepreneur decides, to close down the operations. Hence, it takes the firm to
liquidation. The reason for such a excise would be many:
(i)
Stiff Competition
(ii) Technological Failure
(iii) Poor management by the entrepreneur etc.
Q.
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(2)
Definition of Factoring :
"Factoring means an arrangement between a factor and his client which includes at
least two of the following services to be provided by the factors:
(i)
Finance
(ii) Maintenance of accounts
(iii) Collection of debts
(iv) Protection against credit risk".
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Mechanism of Factoring
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Various activities undertaken by the three parties in a factoring transaction are listed here
under:
Buyer :
(i)
Buyer negotiates terms of purchasing the material with the seller.
(ii) Buyer receives delivery of goods with invoice and instructions by the seller to
make payment to the factor on due date.
(iii) Buyer makes payment to factor in time or gets extension of time or in the case of
default is subject to legal process at the hands of factor.
(2)
Seller :
(i)
Memorandum of Understanding(MOU) with the buyer in the form of letter
exchanged between them or agreement entered into between them.
(ii) Sells goods to the buyer as MOU.
(iii) Delivers copies of invoice, delivery challan, MOU, instruction to make payment
to factor given to buyer.
(iv) Seller receives 80 per cent or more payment in advance from factor on selling
the receivable from the buyer to him.
(v) Seller receives balance payment from factor after deduction of factor's service
charges etc.
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(1)
(3)
Factor :
(i)
The factor enters into agreement with seller for rendering factor services to it.
(ii) On receipt of copies of sale documents as referred to above makes payment to
the seller of the 80 per cent of the price of the debt.
(iii) The factor receives payment from the buyer on due dates and remits the money
to seller after usual deductions.
(iv) The factor also ensures that the following conditions should be met to give full
effect to the factoring arrangements:
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Q.
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The invoice, bills or other documents drawn by the seller should contain a
clause that these payments arising out of the transaction as referred to or
mentioned in might be factored.
The seller should confirm in writing to the factor that all the payments
arising out of these bills are free from any charge, pledge, or mortgage etc.
The seller should confirm that all conditions to sell-buy contract between
him and the buyer have been complied with and the transactions
complete.
Discuss briefly the various forms of factoring. Also explain the advantage and
disadvantage of Factoring.
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(2)
(1)
(3)
(4)
(6)
Undisclosed Factoring : The name of the factor is not disclosed in the invoice
although factor maintains the sales ledger of the supplier or manufacturer. The entire
realization of the business transaction is done in the name of the supplier company
abut all control remains with the factor.
(7)
Domestic Factoring : In the domestic factoring, the three parties involved, namely,
buyer, seller and factor are domiciled in the same country.
(8)
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(5)
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Advantages of Factoring : Following are the advantage resulting from the factoring:
(1) Elimination of trade discounts.
(2) Prompt payments and credits
(3) Reduction in administrative cost and burden.
(4) Increase in return to the client
(5) Improvement in liquidity
(6) Provides insurance against bad debts
(7) It is not bank loan nor a deposit but facilitates liquidity
(8) It avoids increased debts
(9) Better credit discipline amongst customers by regular realization of dues,
effective control of sales journal, reduced credit risk, better working capital
requirement etc.
Disadvantages of Factoring :
(1) Image of the client may suffer as engaging a factoring agency is not considered a good
sign of efficient management.
(2) Factoring may not be of much use where companies have nation-wide network of
branches.
(3) Where goods are sold against advance payment, factoring may not be useful.
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Q.
Write a note on Factoring in India.
Ans. Factoring in India : Some of the major factoring firms in India are:
(1) SBI Factors & Commercial Services Ltd. : SBI gas floated its subsidiary in March,
1991 as SBI Factors and Commercial Services Ltd. which commenced operations in
April, 1991 starting with bill-discounting and other services. SBI FACS contemplated
to undertake collection and credit services designed to improve cash flow of business
concerns, by timely realization of debt or receivables. A seller can have his invoice
converted into instant cash upto 80% without having to wait for 30, 60 or 90 days. SBI
FACS takes the responsibility of collection of debts due from customers of the clients.
It will also undertake the maintenance of client's sales ledger by using the
computerised system. SBI FACS has paid up capital of Rs. 25 crores and had factored
debt of Rs. 30 crores with gross profit of Rs. 2 crores during the year.
(2) Canara Banks Factors Ltd. : Canara Bank Factor Ltd, got approval and was
simultaneously incorporated as subsidiary of Canara Bank in August 1991 and has
been operating in south zone. It has paid up capital of Rs. 10 crores contributed by
Canara Bank, Andhra Bank and Small Industrial Development Bank of India in the
proportion of 60:20:20 and rendering same services as SBI FACS.
(3) Fairgrowth Factors Ltd. : It is the first company in private sector aloe\wed to operate
as factors. It has started its functions in April, 1992 and has paid up capital of Rs.5
crores.
Q.
Define Forfaiting. Explain briefly the Mechanism of Forfaiting.
Ans. Forfaiting : Forfaiting denotes the purchase of trade bills or promissory notes by a
bank or financial institution without recourse to seller. This purchase is in the form of
discounting the bills or notes covering the entire risk of non-payments in collection. Thus, all
risks and collection problems are fully the forfaiter's responsibility who pays cash to seller
after discounting the notes or bills. Forfaiting has been permitted to exporters in India since
1992.Forfaiting is a without recourse finance which converts a credit sale into a cash sale.
Mechanism of Forfaiting : The communication channels and module of transactions in
forfeiting are shown in the following figure:
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Exporter
Agreement
Delivery of goods - export
Delivery of Bills of Exchange
With bank/acceptance guarantor
Payment on Maturity
Diagram : Mechanism of Forfaiting
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Importer
Bank
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Explanation :
(1) Commercial contract between the exporter and importer
(2) Delivery of goods from exporter to importer
(3) Acceptance and delivery of bills of exchange drawn on importer by exporter back to
exporter
(4) Forfaiting contract between the forfeiter and the exporter
(5) Delivery of bills of exchange by exporter to importer
(6) Cash payment by forfeiter to exporter of the face value of bill less discount.
(7) Presentation of bills of exchange on maturity for payment by forfeiter to importer bank.
(8) Payment of bills by importers bank to forfeiter.
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Advantage of Forfaiting :
(i)
Forfaiting enable a broad range of instrument in use like promissory notes, bills of
exchange etc.
(ii) It does not involve any risk on account of foreign exchange fluctuations to exporter
between the insurance date and maturity of paper.
(iii) Exporter faces no administration and collection problems
(iv) It provides finance for counter trade, etc.
Q.
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Forfaiting : Forfaiting denotes the purchase of trade bills or promissory notes by a bank or
financial institution without recourse to seller. This purchase is in the form of discounting the
bills or notes covering the entire risk of non-payments in collection. Thus, all risks and
collection problems are fully the forfaiter's responsibility who pays cash to seller after
discounting the notes or bills.
Distinguish Between Factoring and Forfaiting :
Sr.
No.
1.
Basis
of Difference
Time
Factoring
Forfaiting
Forfaiting is without
recourse to the exporter.
All risks are taken over
by the forfeiter
3.
Cost
Recourse or
without recourse
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Q.
2.
Briefly explain the features of a bill of exchange, its types and advantages.
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Creation of a B/E : Suppose a seller sells goods to a buyer. In most cases, the seller would
like to be paid immediately but the buyer would like to pay only after some time, that is, the
buyer would wish to purchase on credit. To solve this problem, the seller draws a B/E of a
given maturity on the buyer. The seller has now assumed the role of a creditor and is called
the drawer of the bill. The buyer, who is the debtor, is called the drawee. The seller then
sends the bill to the buyer who acknowledges his responsibility for the payment of the
amount on the terms mentioned on the bill by writing his acceptance on the bill. The acceptor
could be the buyer himself or any third party willing to take on the credit risk of the buyer.
Normally there are two parties involved in bill of exchange:
Drawer
Drawee
Discounting of a B/E : The seller, who is the holder of an accepted B/E has two options:
1.
Hold on to the B/E till maturity and then take the payment from the buyer.
2.
Discount the B/E with a discounting agency. This second options is by far more
attractive to the seller. The seller can take over the accepted B/E to a discounting
agency and obtain ready cash. The discounting agency may be a bank, NBFC or a
company. The act of handing over an endorsed B/E for ready money is called
discounting the B/E.
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Discount : The margin between the ready money paid and the face value of the
bill is called the discount and is calculated at a rate percentage per annum on the
maturity value.
Maturity : The maturity a B/E is defined as the date in which payment will fall
due. Normal maturity periods are 30, 60, 90 or 120 days but bills maturing within
90 days seem to be the most popular.
Demand Bill : This is payable immediately "at sight" or "on presentment" to the
drawee. A bill on which no time of payment is specified is also termed as demand bill.
(2)
Usance Bill : This is also called time bill. Usance bill refers to the time period for
payment of bill.
(3)
Documentary Bills : These are the B/Es that are accompanied by documents that
confirm that a trade has taken place between the buyer and the seller of goods. These
documents include the invoice and other documents.
(4)
Clean Bills : These bills are not accompanied by any documents that show that a
trade has taken place between the buyer and the seller. Because of this, the interest
rate charged on such bill is higher than the rate charged on documentary bills.
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(1)
(B)
To Banks :
(i)
Safety of Funds : The greatest security for a banker is that a B/E is a negotiable
instrument bearing signatures of two parties considered good for the amount of
bill; so he can enforce his claim easily.
(ii) Certainty of Payment : A B/E is a self-liquidating assets with the banker
knowing in advance the date of its maturity
(iii) Profitability : Since the discount on a bill is front-ended, the yield is much higher
than on other loans and advances, where interest is paid quarterly or half yearly.
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Q.
What is Hire-purchase System? Also explain the Legal Provisions of HirePurchase System.
Ans. Hire-Purchase System : Hire purchase means a transaction where goods are
delivered to the purchase immediately on signing the agreement and he is called upon to the
purchase price in periodic installments. These installments may be monthly, quarterly, half69
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yearly or yearly depending upon the terms of the agreement. Each instilment is treated as a
hire charge till the payment of the last installment when ownership or property in the goods
passes from seller to the buyer. In case the default is made in the payment of even the last
installment, the seller will be entitled to repossess the goods and forfeit the amount already
received treating it as a hire charge. As such, under this system, the purchaser is called 'Hire
Purchaser' and the seller is called 'Hire Vendor'.
Definitions :
According to J. R. Batliboi :
"Under the Hire Purchase System, goods are delivered to a person who agrees to pa
the owners by equal periodical installments, such installments are to be treated as hire of
these goods, until a certain fixed amount has been paid, when these goods become the
property of the hirer".
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(2)
Payment in Installment : Under section 3 of the Act, it is compulsory that hirepurchase agreement should be in writing and signed b the parties concerned. It must
state the following :
(3)
Right of the hirer to purchase with rebate : The Act confers on the hire purchaser
the right ot purchase the goods b giving 14 day's notice to the owner. In such a case the
hirer is entitled to a rebate calculated in the following formula:
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(4)
(1)
2
Total Hire Purchase Charges x No. of installments not yet due
Rebate = ----- X -------------------------------------------------------------------------------3
Total No. of Installment
The hirer has to pa the balance of the installment amount less rebate calculated as above.
Example : From the following information, calculate the amount to be paid to the owner if the
hire purchaser intends to complete the purchase of goods:
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Rs. 72,000
Rs. 54,000
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Solution :
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18000 x 4
Rebate = ----- X ------------------- = 4,000
3
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The hire purchaser may, therefore, complete the purchase of goods by paying a lump sum of
Rs. 20,000 (24,000-4,000).
(5)
(i)
However, Section 20 of the Act provides that in the following cases, the hire
vendor cannot exercise his right of repossession of goods unless it is
sanctioned by the court:
Where the hire-purchase price is less than Rs. 15000, one half of the price
has been paid;
Refund to the hire-purchaser: In case the hire vendor repossesses the goods,
he is not bound to return the amounts already received as they represent hire
charges but he will be required, under the Act, to refund to the hire-purchaser the
amount by which the total amount received from the hire-purchaser plus the
value of the goods on the date of repossession exceeds the hire purchase price.
(iii)
Right to recover the arrears : In addition to the right to repossess the goods
and the right to retain the installments already paid as hire charges, the hire
vendor also has the right to recover the arrears of installments due on the date of
default.
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Liability of hire-purchaser to keep the goods in good condition : The hirepurchaser, during that period when he is in possession of goods, is supposed to take
all such care of goods a prudent person does in case of his own goods.
(7)
Loss occurring to goods has to be borne by the seller : So long as the hirepurchaser has taken reasonable care of the goods expected from a prudent person,
any loss occurring to goods has to be borne by the seller as the risk lies with the
ownership.
(8)
No right to sell or pledge the goods : As the hire-purchaser is in the legal position of
bailee, he has no right to sell or pledge the goods till he becomes the owner.
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(6)
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Ans. Consumer Credit : Consumer credit includes all asset-based financing plans offered
to primarily individuals to acquire consumer goods. Typically in a consumer credit
transaction the individual-buyer pays a fraction of the cash purchase price at the time of the
delivery of the asset and pays the balance with interest over a specified period of time. The
main suppliers of consumer credit are :
(i)
Foreign/Multinational Banks
(ii) Commercial Banks
(iii) Finance Companies
And cover items such as cars, scooters, VCRs, TVs, refrigerators, washing machines, home
appliances and so on.
Salient Features : The salient features of consumer credit are:
Parties to the Transaction : The parties to a consumer credit transaction depend
upon the nature of the transaction.
(i)
A bipartite Arrangement : There are tow parties:
Borrower
Financier
(ii) A tripartite Arrangement : There are three parties:
Borrower
Dealer
Financier
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(1)
(2)
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Hire-Purchase : The customer has the option to purchase the assets. But he
may not exercise the option and return the goods according to the terms of the
agreement.
(iii)
Conditional Sale : The ownership is not transferred to the customer until the
total purchase price including the credit charge is paid. The customer cannot
terminate the agreement before the payment of the full price.
Credit Sale : The ownership is transferred to the customer on payment of the
first installment. He cannot cancel the agreement.
Mode of Payment : From the point of view of payment, the consumer credit
arrangement fall into two groups:
(i)
Down Payment Scheme : The down payment may range between 20-25 per
cent of the cost of asset.
(ii) Deposit-linked Scheme : The payment may vary between 15-25 per cent of the
amount financed.
(4)
Payment Period and Rate of Interest : A wide range of options are available.
Typically, the repayment period ranges between 12-60 monthly installments. The rate
of interest is normally expressed at a flat rate.
(5)
Security : Security is generally in the form of a first charge in the asset. The consumer
cannot sell the pledge asset.
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(3)
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